Deck 12: The Supply of and Demand for Productive Resources

Question 1

"The demand for resources is a derived demand." What is meant by that statement? Why is the employment of a resource inversely related to its price?

Answer 1

A producer needs different factors of production, like land, labor, capital, and machinery, to produce different goods and services. The demand of these factors of production exists because there is a demand for goods and services they help produce. Demand for factors of production is a derived demand, because the consumer derives it from the production of goods and services, and their demand in the market.
Employment of resources are inversely related to their price, because as the price of these resources increase, the cost of production increases and the producer will move to a lower priced substitute available in the market. On the other hand, if the price of resources is high, it leads to increase in the price of goods and services, and the consumer will move to low priced products. Therefore, the demand for factors of production and price are inversely related.

Question 2

How does a firm decide whether or not to employ an additional unit of a resource? What determines the combination of skilled and unskilled workers employed by a firm?

Answer 2

A firm's decision to hire depends upon the marginal benefit it gets from hiring an additional unit of factor of production and the marginal cost of hiring the additional unit.
The marginal benefit of hiring is measured by the marginal revenue productivity (MRP), which decreases as a firm hires additional units of factor. MRP is the increase in total revenue of the firm by hiring an additional unit of factor, and it is equal to marginal product (MP) of factor and the price (P) of factor. That is,
A firm will continue hiring an additional unit of factor as long as MRP is greater than the marginal cost of hiring an additional unit of factor, and it will stop hiring when MRP becomes equal to the marginal cost.
Assuming that factor inputs are perfectly divisible, the combination of skilled and unskilled labor that will be employed by a profit-maximizing firm will depend upon the MRP and the price of both skilled and unskilled labor.
When the MRP weighted by price of skilled labor is equal to the MRP weighted by price of unskilled labor, it is said that a profit-maximizing firm is minimizing its cost. In other words, when the marginal product per dollar expenditure is equal for all resources, the firm has been said to minimize the cost of hiring multiple resources.

Question 3

*Are productivity gains the major source of higher wages? If so, how does one account for the rising real wages of barbers, who, by and large, have used the same techniques for a half-century? ( Hint: Do not forget opportunity cost and supply.)

Answer 3

Yes , productivity gains are the major source of higher wages because higher productivity of labor results in higher demands of the labor by the firm. As a result, the wages of the labor with higher productivity is pushed up compared to labor with low productivity.
Although productivity is the main force causing a rise in wage, opportunity costs are also an important consideration. The case of the barber is an example of opportunity cost. Due to the rise in relative wages of other factors compared to the barber's wages, the opportunity cost of remaining in the barber business has increased.
Consequently, barbers will consider substituting the barber business with work in high-wage industries. Some may even consider leaving the barber business altogether. Thus, for barbers to remain in the same industry, their wages need to be hiked so that they are comparable to high-wage industries.

Question 4

Are the following statements both correct? Are they inconsistent with each other? Explain.
a. "Firms will hire a resource only if they can make money by doing so."
b. "In a market economy, each resource will tend to be paid according to its marginal product. Highly productive resources will command high prices, whereas less productive resources will command lower prices."

Question 5

*Many school districts pay teachers on the basis of their highest degree earned and number of years of service (seniority). They often find it quite easy to fill the slots for English and history teachers, but very difficult to find the required number of math and science teachers. Can you explain why?

Question 6

Suppose that you were the manager of a large retail store that was currently experiencing a shoplifting problem. Every hour, approximately $15 worth of merchandise was being stolen from your store. Suppose that a security guard would completely eliminate the shoplifting in your store. If you were interested in maximizing your profits, should you hire a security guard if the wage rate of security guards was $20 per hour? Why or why not? What does this imply about the relationship between average shoplifting per hour in the economy and the wage rates of security guards?

Question 7

*A dressmaker uses labor and capital (sewing machines) to produce dresses in a competitive market. Suppose the last unit of labor hired cost $1,000 per month and increased output by 100 dresses. The last unit of capital hired (rented) cost $500 per month and increased output by 80 dresses. Is the dressmaker minimizing costs? If not, what changes need to be made?

Question 8

A firm is considering moving from the United States to Mexico. The firm pays its U.S. workers $12 per hour. Current U.S. workers have a marginal product of forty, whereas the Mexican workers have a marginal product of ten. How low would the Mexican wage have to be for the firm to reduce its wage cost per unit of output by moving to Mexico?

Question 9

*"The earnings of engineers, doctors, and lawyers are high because lots of education is necessary to practice in these fields." Evaluate this statement.

Question 10

Other things constant, what impact will a highly elastic demand for a product have on the elasticity of demand for the resources used to produce the product? Explain.

Question 11

Leisure Times, Inc., employs skilled workers and capital to install hot tubs. The capital includes the tools and equipment workers use to construct and install the tubs. The installation services are sold in a competitive market for $1,200 per hot tub. Leisure Times is able to hire workers for $2,200 per month, including the cost of wages, fringe benefits, and employment taxes. As additional workers are hired, the increase in the number of hot tubs installed is indicated in the table.
a. Indicate the marginal product and MRP schedules of the workers.
b. What quantity of workers should Leisure Times employ to maximize its profit?
c. If a construction boom pushes the wages of skilled workers up to $2,500 per month, how many workers would Leisure Times employ to maximize its profit?
d. Suppose that strong demand for hot tubs pushes the price of installation services up to $1,500 per month. How would this affect employment of the skilled workers if the wage rate of the workers remained at $2,500 per month?

Question 12

A recent flyer on a university campus stated that consumers should boycott sugar due to the low wages earned by laborers on sugar cane farms in Florida. Using the notion of derived demand, what impact would a boycott on sugar have on the wages of the farm laborers in the short run? In the long run? *Asterisk denotes questions for which answers are given in Appendix B.